Planning externalities

The Finance Minister's speech to the Victoria University Business and Investment Club last week was excellent. I was not in attendance, but the text is now available online.

After running through a litany of areas where the application of market signals through policy reform improved outcomes - from agriculture to energy, he turns to housing. He walks through how urban planning regulations have jacked up housing costs, delayed new construction, worsened housing price cycles, hurt economic growth, driven inequality and cost the government plenty in state housing and accommodation supplements.

So these are the reasons why the Government pays attention to the housing market and issues stemming from poor planning.

For those among you who are economists, I would go so far as to say that while the justification for planning is to deal with externalities, what has actually happened is that planning in New Zealand has become the externality.

It has become a welfare-reducing activity.

And as with other externalities, such as pollution, the Government has a role to intervene, working with councils to manage the externality.

We're starting to get analysis that shows planning’s costs.

Too often the discussion about how our cities are planned is couched in vague terms of general good. "A world-class city." "Quality urban design." "A liveable, walkable city."

Those are all desirable, achievable objectives. But we need to understand the costs of achieving them so that we can make the trade-offs transparent.

I love it when people rediscover Tullock's 1998 argument that policy itself generates external costs that are underappreciated - which was of course simply an extension of his 1962 work with Buchanan on external costs and decision-making costs in The Calculus of Consent.

And it gets better:

As we get more information about what actually happens, often we find planning doesn’t achieve what people think it is achieving.

Planners and councils have a very difficult job in planning our urban areas.

Cities are incredibly complex systems. They are the product of millions of individual choices.

The idea that a small group of people could understand what choices we're making is asking too much of them.

Not because they are in any way incapable. But because the task is overwhelming.

The Auckland Unitary Plan is 3,000 pages long.

It's trying to regulate everything from the size of bedrooms to biodiversity in the Waitakere Ranges. No one person could possibly understand all the trade-offs in that plan.

Which means many of its effects will be certainly be unintended.

Planners can’t know everything – so of course they can’t be perfect in making trade-offs on our behalf.

Successful planning requires an understanding of its own limitations.

And then we come to the meat:

The funding base for councils is increasingly people on low fixed incomes. That is a product of an ageing population.

So you can understand why councils are under pressure not to expand if they think an expanding city is going to push up rates for existing ratepayers.

Councils need clear funding models so that development worth having can occur and future homeowners and current renters who might want to buy are taken into account.

So that's a brief overview of how important it is that housing is regulated in a way that enables flexible supply, and I hope some indication of the progress we're making.

That progress is necessarily slow, because these issues are complex.

If we better understand the economics of what is happening we can make better choices about housing regulation.

And that depends on one of the most important parts of public policy, which is the institutional arrangements by which those decisions are made.

That means looking at the incentives confronting an individual sitting in a council when making a decision about whether to allow a new subdivision.

We need to understand the incentives councils are reacting to.

Next month the Productivity Commission will produce a further report on the regulation of land supply. It will be another input into further, ongoing improvements in this area.

And we are seeing new thinking on a range of issues affecting housing, including from councils.

Often politicians are accused of being focused on the short term. That’s one of the reasons this issue has never been dealt with properly in the past.

The Government is taking a long term view.

All of the things I've talked about today will take 10 to 15 years to sort out.

So it’s important that a broad group of people understand our single-biggest asset class – the most-important asset most of us will own – how is valued, how it is regulated, and how it can contribute to our general welfare.

The New Zealand Initiative's report on policy trial zones, coupled with improved council financial arrangements to strengthen incentives, will be coming out 19 October.

I hope to see you at the report launch.